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Child endangerment conviction found not to be good cause for immediate termination of franchise

The United States District Court of New Jersey recently decided that a franchisee's child endangerment criminal conviction did not justify immediate termination of a franchise agreement under the New Jersey's Franchise Practices Act (FPA).

Franchisor, International House of Pancakes (IHOP), terminated a New Jersey IHOP franchisee after learning that its President and majority owner plead guilty to a charge of endangering the welfare of a child. As a result of the plea, the franchisee owner must register as a sex offender and go to jail for 3 years. When the franchisee continued to operate as an IHOP franchisee, despite the termination letter, IHOP filed an preliminary injunction to bar the terminated franchisee from further use of its trademarks.

The District Court denied the preliminary injunction filed by IHOP ruling that IHOP's immediate termination of the franchisee violated the FPA which permits immediate termination of a franchisee for the conviction of an indictable offense when the offense is "directly related to the business conducted pursuant to the franchise." Since the court record did not show that the crime either occurred at the IHOP location, resulted in adverse publicity or had any other direct nexus with the franchise, IHOP was required to give the franchisee 60 days notice of termination under the FPA.

The District Court did not accept "potential damage to a franchisor's brand, standing alone" as sufficient to satisfy the "directly related" standard of the FPA. Because the court concluded that the franchise agreement had not been properly terminated under the FPA, IHOP could not succeed on its motion to enjoin the franchisee from using the IHOP's marks.

Given the regular concern we have for the protection of the brand--which benefits franchisees and franchisors alike--we are disappointed with this decision. Moreover, it flies in the face of other recent decisions that require franchisors to protect the brand. Nevertheless, cases such as this one demonstrate courts can and sometimes do interpret the rights of franchisees under state franchise protection laws quite broadly. The case is a good reminder that franchisors must always consider the potential consequences of any applicable state laws at the time of potential termination, and consider discussing the potential termination with legal counsel.

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